The Financial Reporting Council’s (FRC) recent position paper, Restoring Trust in Audit and Corporate Governance, offers an early look into how the sustainability aspects of the UK government’s corporate governance reforms are likely play out in practice. Below, we look at some of the key ESG-related proposals which will be of interest to boards and their expected timings.
In due course, the government will look to bring in legislation to strengthen the UK’s corporate governance, reporting and audit systems in the wake of its recent consultation. In the meantime, the FRC’s position paper covers how and when the FRC plans to help achieve the government’s ambition.
More to come…
In particular, it outlines a number of positions relating to sustainability, including its proposed updates to the Corporate Governance Code, Strategic Report guidance, and non-financial reporting. More substantive detail from the FRC will need to follow as the legislation progresses.
Boards looking to shape a response—or at least better understand and prepare for what is coming from a sustainability and ESG perspective—can benefit from engaging early with the FRC’s proposals.
Overall, the FRC’s chosen areas of focus reflect a continuing shift towards integrating and hardening ESG and sustainability-related expectations within the UK regulatory ecosystem—a shift that boards will want to stay ahead of in order to be best placed to adapt and compete.
The key proposals:
Updating the UK Corporate Governance Code
Amongst other revisions to the code, changes will be made to reflect the wider responsibilities of the board and audit committee for expanded sustainability and ESG reporting and, where commissioned by the company, appropriate assurance in accordance with a company’s audit and assurance policy. Businesses who are required to follow the code under the listing rules, or who do so voluntarily, will be required to take steps in due course to integrate these changes for periods commencing on or after 1 January 2024.
Updating strategic report guidance
Subject to the government finalising how it intends to implement the International Sustainability Disclosure Standards (ISSB) in the UK, the FRC will revise its strategic report guidance, so that the strategic report remains a source of decision-ready information. Timing will be informed by stakeholder engagement and market needs so is currently to be determined.
Sustainability reporting
As expected, the FRC has said it strongly supports the efforts of the ISSB to develop a global baseline to support sustainability reporting and will work closely with international regulators and standard setters. Businesses familiar with the Task Force on Climate-related Financial Disclosures (TCFD) reporting will be well placed to comply with the ISSB’s framework, although will need to take some additional steps.
It is worth noting that the ISSB and TCFD approaches both focus on the risks and opportunities that businesses face from climate and sustainability, but not the risks and opportunities businesses pose to them.
Accordingly, the FRC has not commented on the so-called “double materiality” approach here, or in their recent response to the ISSB’s exposure drafts of their draft disclosure standards. However, since double materiality forms part of the EU’s approach to corporate sustainability reporting and likely the UK’s sustainability disclosure requirements regime, it may be that they will have to say more on this later.
Reducing reporting burdens
The FRC also proposes to work with BEIS to help reduce current non-financial reporting burdens on companies, and are looking at opportunities to simplify and improve reporting requirements without reducing quality, including in financial statements and the front half of the annual report.
It is not clear yet what this means in practice, but simplification should generally be welcomed for reducing burdens and increasingly comparability and transparency.
Review of new reporting requirements
The FRC intends to include in its review processes any new reporting disclosures the government introduce straight away, and is already piloting inclusion of some non-financial reporting, such as corporate governance disclosures and remuneration reporting.
They will also continue to publish the outcomes of their corporate reporting reviews of public and large private companies, including any findings related to non-financial disclosures where appropriate, which can be a source of guidance as to best practice, as well as a reputational risk to be considered.
This comes ahead of the FRC’s metamorphosis into the more powerful Audit, Reporting and Governance Authority (ARGA) over the next three years. ARGA will have the power to oversee corporate reporting and audit and to sanction directors for breaches of their corporate duties. New corporate reporting requirements are also being introduced alongside measures to reform the audit market.
These new powers—to review reports and to sanction directors for failure in their corporate reporting and audit responsibilities—will likely focus minds on the verifiability of non-financial disclosures and on the quality of the internal controls and assurance processes that support them.
George Murray is a climate change and sustainability specialist and senior professional support lawyer at Slaughter and May